Your Responsibilities as a Director of a Portfolio Company


Guidelines for Special Committees

For many transactions involving private equity funds, the board of directors of the target company or portfolio company must be sensitive to the fact that its decisions will be subject to a more rigorous and demanding standard of review if those decisions are challenged in litigation. For example, when a private equity fund proposes a "going private" transaction involving a public company or when a portfolio company engages in a transaction with its private equity fund owner or its affiliate, a court would review the "entire fairness" of the transaction. 1 For a transaction to be "entirely fair," it must satisfy two requirements: there must have been "fair dealing" and there must be a "fair price."

In these situations, a common way for a board of directors to bolster its position that a transaction is "entirely fair" is to use a special negotiating committee of independent directors to evaluate the proposed transaction.

In this newsletter, we note important guidelines for the special committee process:

  1. Assemble your special committee early in the transaction process, before a deal is imminent. A special committee must be given a reasonable opportunity to review and consider a proposed transaction, and should be an active participant in the negotiations. Accordingly, the committee must be formed (and informed) early in the process. If the transaction is later challenged in litigation, the court will conduct a highly fact-intensive review of the special committee process, including consideration of a number of factors that are not discussed here, so consulting your advisers early in the process is essential.
  2. Give the committee a clear mandate, including, possibly, decision-making authority. Establish a clear, written mandate setting out the committee's powers and responsibilities. This mandate should include the power to fully evaluate the transaction and the critical power to say "no" to the transaction. When a controlling shareholder proposes to acquire the rest of the corporation from the minority shareholders, the special committee's options may be limited to saying "no" or negotiating the terms of the transaction with the controlling shareholder. In other cases, such as a "going private" transaction, the special committee's mandate should extend to considering alternatives to the transaction. Here, the committee should have the authority to contact one or more potential bidders, or even conduct a full auction, if it considers these actions to be appropriate. Finally, in limited cases it may even be appropriate to consider empowering the special committee to approve, rather than simply "recommend" the transaction to the full board.
  3. When assembling the special committee, choose more than one member if possible. The composition of the special committee is of central importance to the entire process. Whenever possible, the special committee should comprise more than one member. Courts often give greater weight to the deliberations of a multi-member committee where there is an opportunity for debate and oversight than to the determination of a one-person committee.
  4. Ensure that all members of the committee are as independent and disinterested as possible. The members must be independent and willing to perform their responsibilities. Past and current affiliations and arrangements of the members should be considered to ensure that no member could reasonably be viewed as insufficiently independent or having a self-interest in the transaction.
  5. Select members who will be active. The members should be prepared to be active, vigorous participants in the process and to keep themselves fully informed of all material information about the negotiations and alternatives to the transaction.
  6. Ensure that members of the special committee understand their responsibilities. Members of a special committee should be able to articulate the extent of the special committee's powers and responsibilities. The fact that the special committee has a proper mandate may not be sufficient if the special committee does not understand what it properly can and is supposed to do. A special committee's misunderstanding of its purpose and mandate could be combined with other factors to show that a special committee's effectiveness was compromised from the beginning.
  7. Enable the committee to have access to knowledgeable and independent advisors, including legal and financial advisors. The committee should be empowered to appoint its own knowledgeable and independent advisors, including legal and financial advisors. The special committee's advisors should have no disabling past or present affiliations or arrangements with the interested party.
  8. Maintain confidentiality. The special committee should be particularly sensitive to its duty of confidentiality. In order to maintain the integrity of the special committee process, the committee should consider establishing formal processes and procedures to manage communications between committee members and the rest of the board and management.
  9. Document committee deliberations in board minutes. A special committee should prepare and maintain current and accurate minutes of its meetings and discussions.
  10. Encourage (and if the company is for sale, require) the committee to consider alternative transactions. If a determination is made to sell the corporation in a change of control transaction for cash, the special committee members will have a separate duty - the so-called "Revlon duty" - to obtain the best price reasonably attainable for the corporation's shareholders. This means that the committee will be required to weigh the desirability of a pre-signing market check on the one hand, against that of a post-signing fiduciary out/go-shop, on the other hand. 2